Question 12.10: A cycling shop is deciding whether to sell bicycles assemble...
A cycling shop is deciding whether to sell bicycles assembled or unassembled. An unassembled bicycle is purchased by the store for $100 and can be sold unassembled for $200. To assemble a bicycle requires one hour of labor time. Labor costs $16 per hour. If the shop assembles the bicycle, it sells for $275. At a price of $275, the number of assembled bicycles sold would equal the number sold unassembled. Should the bicycle be assembled by the cycling shop or sold unassembled?
The incremental revenues are $275 – $200, or $75. The incremental costs are the cost of assembly, (1 hour × $16 per hour), or $16. The incremental revenues are greater than the incremental costs, so the bicycle should be assembled by the cycling shop. Note that the shop’s purchase cost of $100 is irrelevant to the decision. Once the shop purchases the unassembled bicycle, the $100 is a sunk cost.